When should workers take a pension buyout?

A Ford logo is seen on the car maker's booth during the first media day of the Geneva Auto Show at the Palexpo in Geneva, March 6, 2012.Denis Balibouse

CHICAGO (Reuters) - Ford Motor Company is making an offer it hopes 90,000 former employees can't refuse: a lump sum buyout of their pensions.

The auto giant plans to offer a voluntary buyout of defined benefit pensions to salaried retirees and former employees, with payouts to start later this year.

Although Ford hasn't revealed the exact terms of the payments, the scale of the offer is unprecedented for a corporation that isn't actually terminating a pension plan. Ford hopes the strategy will reduce its pension liabilities and balance sheet volatility. If successful, Ford could be starting a trend that other companies follow.

Is a lump sum offer a good deal for Ford's pension beneficiaries? How about workers at other companies, many of whom are offered lump sum options at retirement in lieu of a lifetime income stream from a pension?

I posed the question to one of the top experts in North America on pensions, retirement and annuities - Moshe A. Milevsky. He's a finance professor at the Schulich School of Business at York University in Toronto and CEO of QWeMA Group, which licenses intellectual property and algorithms used in retirement calculators. His latest book, "The Seven Most Important Equations for Your Retirement and the Stories Behind Them" (John Wiley & Sons), was published this week.

Milevsky cautions that there's no one-size-fits all answer.

"But my default position is not to take the lump sum and I therefore have to be convinced to give up the pension annuity. Not the other way around," he says.

"In most cases, the lump sum won't compensate for loss of the pension, unless you're in poor health and don't expect to live very long."

In deciding whether a lump sum is a good deal, Milevsky advises retirees to consider three key factors:

Mortality. "How healthy do you think you are in relation to the rest of the population? If you have reason to think you'll live longer than average, the pension probably beats a lump sum."

Interest rates. The lump sum is a good deal only if you are very certain you can beat the rate of return (referred to by the numbers folks as the "discount rate") that your pension plan is using to calculate what your pension is worth as a lump sum.

"We're in a very low rate environment, so that makes the pension worth more," says Milevsky.

By law, the lump sum calculation is pegged to yields on corporate bonds. The rates vary depending on your age and are adjusted monthly by the Internal Revenue Service. The published rate for March for a 65-year-old is about 4.25 percent, according to Ellen Kleinstuber, a principal with Savitz Organization, an actuarial consulting firm. For that retiree, the choice would be between receiving $700 per month lifetime, or approximately $108,000 as a lump sum.

That means, in order to come out ahead, you'd need to be able to beat that 4.25 percent rate investing the lump sum. That's impossible to do if the money is invested in risk-free investments, such as certificates of deposit. You could choose to assume a higher rate of return from investing in equities, but the risk must be factored in, Milevsky cautions.

The amount you're getting. "How much is your employer actually proposing to give you? If it's a trivial sum, take the lump sum," Milevsky says. "If it's a large amount, you need to run the numbers."

Lump sums have two other potential pitfalls.

The actuarial tables that govern lump sum calculations are unisex. That's bad news for women, since they outlive men, on average, by about four years. That means female workers who take lump sums get shortchanged compared to male workers.

You also may get shortchanged on the value of any early-retirement pension sweeteners your employer might offer for early retirement, because they generally aren't included in lump sum calculations (a consideration that doesn't apply to Ford, since all the workers involved are retired or former employees.)

Although Milevsky leans in most cases toward keeping the pension, he notes that there are a couple downsides to pension annuity streams, too. First, private sector pensions aren't adjusted for inflation, so the value of the income streams erodes over time.

Safety is another concern. In the event that your employer goes belly up and the plan defaults on its obligations, the government-sponsored Pension Benefit Guarantee Corporation (PBGC) steps in to take over and continue making payments. But highly-paid workers could be in line for benefits that exceed the PBGC's insurance protection levels. The payout rates available from the PBGC are based on your age at the time the plan is terminated and are updated annually (here). For 2012, the maximum monthly benefit for workers retiring at age 65 is $4,653.41, or $4,188.07 if you elect a joint and survivor option that pays benefits to a spouse.

Milevsky's book contains formulas for figuring this out - but he urges retirees at Ford and elsewhere to get a professional financial planner to run the numbers, given the magnitude of the decision and the complex factors involved.

"You need someone who can work it through on a spreadsheet," he says. My view: your best bet is a fee-only planner, since planners compensated on a percentage of your portfolio have a built-in vested interest in a lump sum decision.

As a researcher, Milevsky also hopes someone will study the decisions made by Ford workers, given the unprecedented size of the group facing the lump-or-not decision.

"I hope someone keeps careful data on who chooses what," he says. "It will be a gold mine for researchers on human behavior and behavioral finance."

He adds that it's a shame workers aren't given a choice to take a portion of their benefit as a lump-sum and a portion as a pension annuity.

"All-or-nothing decisions are always harmful relative to the ability to diversify," he says.

Milevsky could get his wish soon; the U.S. Treasury has proposed a rule changes that would make it easier for plan sponsors to offer that kind of flexibility as part of a broader set of policies aimed at expanding lifetime income choices available to retiring workers.

(The writer is a Reuters columnist. The opinions expressed are his own.)